The Cost of Capitalv必看课件资料.ppt

CHAPTER 6The Cost of Capital Cost of Capital Components Debt Preferred Common Equity WACC What types of long-term capital do firms use? Long-term debt Preferred stock Common equity Should we focus on before-tax or after-tax capital costs? Should we focus on historical (embedded) costs or new (marginal) costs? Cost of Debt Method 1: Ask an investment banker what the coupon rate would be on new debt. Method 2: Find the bond rating for the company and use the yield on other bonds with a similar rating. Method 3: Find the yield on the company’s debt, if it has any. A 15-year, 12% semiannual bond sells for $1,153.72. What’s rd? Component Cost of Debt Interest is tax deductible, so the after tax (AT) cost of debt is: rd AT = rd BT(1 - T) = 10%(1 - 0.40) = 6%. Use nominal rate. Flotation costs small, so ignore. What’s the cost of preferred stock? PP = $113.10; 10%Q; Par = $100; F = $2. Picture of Preferred Note: Flotation costs for preferred are significant, so are reflected. Use net price. Preferred dividends are not deductible, so no tax adjustment. Just rps. Nominal rps is used. Is preferred stock more or less risky to investors than debt? More risky; company not required to pay preferred dividend. However, firms want to pay preferred dividend. Otherwise, (1) cannot pay common dividend, (2) difficult to raise additional funds, and (3) preferred stockholders may gain control of firm. Why is yield on preferred lower than rd? Corporations own most preferred stock, because 70% of preferred dividends are nontaxable to corporations. Therefore, preferred often has a lower B-T yield than the B-T yield on debt. The A-T yield to investors and A-T cost to the issuer are higher on preferred than on debt, which is consistent with the higher risk of preferred. Example: What are the two ways that companies can raise common equity? Directly, by issuing new shares of common stock. Indirectly, by reinvesting earnings that are not paid out as dividends (i.e., retaining ea